Larry Ribstein's got a nice analysis of the legal questions raised by the prospect that Rupert Murdoch might pay more for the supermajority voting shares owned by the various Bancroft holders than for the regular voting shares held by everybody else. Some will argue that, since both classes of shares have essentially the same economic rights, they should have the same value in a sale. Yet, as Larry points out:
Not permitting [a controlling] shareholder to reap the premium may stop the sale because he may not want to sell unless he can get some gelt to salve the pain of losing control. That may well be a consideration in the DJ situation, since the Bancrofts obviously derive status and satisfaction from their power.
"Steve" (not your truly) left a comment on Larry's post arguing that under Delaware law (is Dow Jones a Delaware corporation?) there would be no real obstacle to the Bancroft entities getting a premium.
As "Steve" notes, the chief problem case is In re Tele-Communications, Inc. Shareholders Litigation, 2005 WL 3642727 (Del.Ch. 2005), in which Chancellor William Chandler indicated that the entire fairness standard would be applied where the supermajority voting shares got a premium. In that case, however, a substantial percentage of the supermajority were held by directors. The deal was thus more closely akin to an interested director transaction than one involving a controlling shareholder. Chandler wrote: "no single shareholder possessed more than 50% of the vote, but the financial interests of a number of directors holding large amounts of TCOMB shares significantly diverged from the interests of their constituent shareholders. ... Alternatively, evidence in the record suggests that a majority of the board of directors were interested in the transaction, requiring an entire fairness analysis."
TCI thus could be distinguished on grounds that the Bancrofts are mere shareholders, whose fiduciary duties have always been regarded as less demanding than those of directors. Conversely, however, if entire fairness is the test, Chandler's opinion indicates that paying a premium to the supermajority voting shares could constitute an unfair price to the non-controlling shareholders. More precisely, he said it presented a "triable issue of fact." Unfortunately, the case was settled without resolution of that issue.
Broc Romanek opined that "many commentators will criticize the court's apparent focus on the historical relative trading prices of a liquid low vote stock and an illiquid high vote stock and the numerous precedent transactions in which holders of high vote stock had foregone a premium even though they may have been legally and economically entitled to one (e.g., the fact that holders of high vote stock may be willing to forego a control premium to avoid litigation is not much help or particularly relevant when negotiating with a large holder of high vote stock like John Malone who adamantly insists on extracting a premium to which he is legally entitled)."
McDermott Will & Emery complained that Chandler thought "that the special committee should have requested a “relative fairness” opinion from its financial advisor (i.e., an opinion as to whether the transaction was fair to the holders of shares of the TCI Group’s low-vote stock in light of the preferential payment being made to holders of the high-vote stock)." As MWE explained, however: "Given that allocating consideration among different classes of capital stock could require a financial advisor to draw legal conclusions, financial advisors often refuse to deliver opinions in respect of such types of allocations."
A Cleary Gottleib M&A newsletter argued that Chandler improperly relied on cases involving recapitalizations:
A recapitalization is, in effect, a reshuffling of the interests of a corporation’s security-holders and is, in that sense, a zero-sum game in which any gain by one constituency necessarily comes at the expense of another constituency. Such a transaction can be “fair” to a constituency only if it does not unduly diminish that constituency’s interest in the corporation, and therefore a fairness analysis should include an examination of the allocation of the post-recapitalization pie. A third-party acquisition, by contrast, is not a zero-sum game as to the separate classes of target stock; since an acquiror often pays a premium above the market value of the target corporation, it is possible for all stockholders to receive a fair and attractive price even if some stockholders receive a greater portion of the total consideration.
That makes sense. It also suggests that it would be okay to pay a control premium to the Bancrofts.
Cleary's analysis also suggests that Chandler may have overlooked the point Larry makes above:
if a transaction promises to deliver a fair price to all stockholders, are directors nevertheless precluded from approving the transaction because it also involves what might be viewed as an unduly generous payment to controlling stockholders who refuse to sell on lesser terms? The TCI court’s approach implies that a board should reject a transaction, even though it “unlocks” premium value for all stockholders, simply because the controlling stockholder insists that he will not approve the transaction (which, it is clear, he has no obligation to do) unless he receives what may be seen by a court as an excessive payment.
As I read TCI, two conclusions may be drawn. First, a review of Chandler's opinion demonstrates that most of his concern seems to have been with the process by which the merger was negotiated. Basically, the special committee of directors that negotiated on behalf of the target was uninformed and less than vigorous. A decision to pay a control premium to the supermajority voting shares reached after an adequate decisionmaking process likely would have received somewhat greater deference. Murdoch and the Bancrofts can afford really good lawyers. There's no excuse for process inadequacies, especially in a deal that is this high profile.
Second, TCI left open an interesting question: Is it proper to pay a control premium to a supervoting class of shares or only to a controlling shareholder. TCI's Class B shares (which had the super voting rights) were owned by a number of investors. It was not the Class B holders as a cohesive group that controlled TCI, however. Instead, TCI was controlled by John Malone by virtue of Malone's holdings of both Class A and Class B stock. Although Malone wanted a premium for the Class B shares, maybe Malone should have gotten a premium for his shares of either class. Malone's lawyers argued it would have been improper for the board to discriminate amongst shareholders in this way. Given that Delaware (unlike some other states, including New York) approved the idea of poison pills that discriminate against specified shareholders, perhaps Delaware would allow allocation of merger premia discrimination in favor of certain shareholders? (Obvious, we're not talking about any form of invidious discrimination here.) On that issue, Cleary makes an interesting argument:
The TCI decision also fails directly to confront the defendants’ argument that the 10% premium paid to holders of TCOMB shares was a legitimate control premium. In advancing this argument, they relied on the well-established principle that a controlling stockholder is entitled to sell his shares at a price that reflects a control premium. Given that entitlement, AT&T could have purchased Malone’s shares at one price, and then offered to purchase the remaining shares of TCI at a lower price. Or, Malone himself could have taken TCI private (at a price per share that was fair, but less than the price per share that a third party might be willing to pay for all of the shares of TCI), and subsequently sold the entire company to AT&T at a higher price per share. In either situation, the TCI directors’ fiduciary duties would not require them to reject the transaction in which the noncontrolling TCI stockholders’ shares would be acquired merely because the price offered in that transaction was lower than the price obtained (or that could be obtained) by Malone for his shares. We do not believe that a controlling stockholder should be any less entitled to obtain a control premium simply because the entire company is sold in a one step transaction.
Ultimately, however, I don't find this argument persuasive. A control premium is paid to the person(s) who have control in order to persuade them to allow the deal to happen. Paying a control premium to some non-controlling shareholders (who hold Class B shares) and not to others (Class A holders) does start to look a fiduciary duty problem.
All of which leads to the question of whether controlling shareholders ought to be allowed to get a premium for their shares. My answer: It depends.
Courts have not imposed a general obligation for controlling shareholders to share a control premium with the minority. The conventional explanation given by the courts is that it is not per se wrong for a controlling shareholder to sell at a price significantly higher than that available to noncontrolling shareholders. It becomes wrong only under special circumstances, such as sale to a looter, sale of office, or taking of a corporate opportunity. In contrast, many scholars have argued for some sort of sharing or equal opportunity rule. Should we adopt such a rule? In short, no.
One of the risks minority shareholders assume when they acquire stock in a corporation with a controlling shareholder is that the latter may sell at a premium without giving the minority an opportunity to participate. If the control block existed when the minority shareholder invested, the minority shareholder presumably paid a lower per share price than he would have paid in the absence of a controlling shareholder. In other words, assuming full disclosure, the minority became shareholders having accepted as adequate whatever trade-off was offered in recompense. Even if the control block was assembled after the minority shareholder invested, moreover, the possibility that such a block would be assembled is one of those risks of which a rational shareholder should be aware in making pricing decisions.
Bounded rationality and other transaction cost obstacles to complete contracting, of course, somewhat weaken the foregoing argument’s force. Even if the pricing mechanism does not adequately protect minority shareholders, however, there are still efficiency arguments in favor of a no sharing rule. If we believe corporate takeovers promote economic efficiency by displacing inefficient incumbent managers, for example, controlling shareholders generally should be allowed to keep their premiums. Unequal distribution lowers the cost of doing takeovers, because the new controlling shareholder only needs to buy the control block, which should result in more takeovers. Giving the controlling shareholders a special premium, moreover, essentially bribes them to quit. Consequently, a no sharing rule should facilitate replacement of inefficient incumbents.
The Sinclair Oil case provides the right analogy. As long as the controlling shareholder does nothing to leave the minority worse off, it should be allowed to sell on whatever terms the market will bear. Doing so is consistent with the reasonable expectations of minority shareholders and promotes efficient changes in control. If controlling shareholders could engage in transactions that affirmatively injure the minority, however, the latter doubtless would take precautions to prevent such transactions. By providing a coercive backstop preventing such transactions, the Sinclair Oil-based default rule minimizes bargaining and enforcement costs.
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COMMENT:
AUTHOR: Steve (not Bainbridge)
DATE: 08/03/2007 06:10:04 AM
You wrote: "Second, TCI left open an interesting question: Is it proper to pay a control premium to a supervoting class of shares or only to a controlling shareholder."
You hit the nail on the head. Luigi Zingales at Chicago has done some interesting work on this, but he didn't look at mergers. I believe that his work shows (perhaps intuitively) that a buyer will not pay in open market purchases a premium for any shares beyond majority voting power because there is little incremental benefit beyond that point. If you look at empirical evidence for mergers, however, whenever the high-vote class receives a premium, then in almost all situations the entire high-vote holders get it (i.e., no price differentiation within the class, only class-to-class). It bears noting that price discrimination (which you noted was permitted in the context of poison pills) is also permissible as a general matter in mergers. As Bill Allen explained, “So if the law were to be unyielding that there never could be discrimination between shareholders holding the same security, then you might encounter situations in which no transaction could be done at all. And it is not in the social interest… to have a rule that prevents efficient transactions….” In re Times Mirror Co. S’holders Litig., 1994 WL 1753202, at *2.
As you note, the board is in an interesting situation if they are asked to pay a control premium to the controlling stockholder AND the other non-controlling high-vote holders. Should Dow Jones's board have agreed to a control premium for the Bancrofts paid pro rata to them only up to a majority of their voting power? What if, as was alleged in TCI, the controlling stockholder demanded that the only way he'd vote for the deal was that if all high-vote holders received the same premium shares? Does the board breach its duties by granting the controller's demands, notwithstanding it's still a great deal for all stockholders? Or has the controller somehow breached its fiduciary duties by making such a demand? All interesting questions that didn't get the treatment they deserved in TCI.
I agree completely that TCI was complicated by the interested-director aspect. In particular, the decision points out the difficulty in taking off one's director hat and just wearing a controlling stockholder hat to vote out of "whim or caprice," as the Delaware courts like to say.
Interesting point regarding Sinclair. It would seem to work in a straight-forward sale of control and other going concern transactions. But in a merger, I think minority stockholders would argue that any control premium was a benefit to the controller at their expense (i.e., lower per share consideration). I think the courts would assume a premium is permissible, so they'd then have to determine whether the actual premium paid was excessive.... At the point, you lose the benefit of Sinclair's bright-line rule b/c the situation becomes very fact intensive.
